4 Lessons from the Real Estate Crash in US

The real estate market has been heating up in India; you can see people advertising real estate jobs on Facebook and the other day I received an email on doing a Diploma in Real Estate!

All this reminds me of the real estate crash in the US that took place about 3 years ago, and there are several lessons we can draw from those events.

Keeping these things in mind may end up saving you from facing a bad real estate investment yourself, so read on!

1. Don’t over – leverage: During the peak of the housing boom it was common to see people owning two or three houses or buying a house that was worth a lot more than what they could afford.

Banks gave housing loans with teaser rates to entice people to buy a house which was actually a lot more than they could have afford.

Banks also enticed people by giving them ARMs (Adjustable Rate Mortgages), which initially had a low interest rate, and would then reset to a higher rate after some time. The idea was to get people to take a huge loan at an artificially lowered interest rate, and then when the interest rate resets upwards get that person to take another loan at a lower rate. This was only possible till the time house prices went up, and when prices started to fall – banks didn’t reset their rate and it soon became apparent to people that they can no longer afford to pay the monthly installment on their loan.

A lot of people badly extended themselves by taking out huge loans in the US, and they had to pay very dearly for that – in a lot of cases such houses went into foreclosure as well, and people not only lost the money they paid off in installments but their houses as well.

The lesson here is to not fall for teaser rates, and stick to a loan amount that you can pay off easily. Housing loans last for number of years, and if you over – extend yourself, sooner or later you will repent it.

2. Don’t treat your house as an ATM: HELOCs or Home Equity Line of Credits became very popular during the housing boom. Suppose you take a house on a loan which is worth Rs. 50 lacs, but you have already paid Rs. 25 lacs on this loan. So, in this case you have equity of Rs. 25 lacs in the house and banks were willing to loan you money against this.

Two problems surfaced with this: If you took out a loan of Rs. 25 lacs and the value of the house fell, then the banks will call back their loan, and that will spell trouble for you.

The second issue was that people took out loans out of this and spent it on luxuries like vacations or remodeling their kitchen. It’s like selling the family silver to pay for a big shopping day. Even if home prices don’t fall this is not a good strategy and is only likely to cause heartache in the long run. Treat your primary home as a residence, and not like an ATM – even if the prices go up.

3. Understand that house prices can fall:A lot of people were under this illusion that house prices can only go up, and ignored examples from other countries like Japan where property prices had crashed before they had done so in the US.

If your rationale for buying real estate is that house prices never crash, then you’re living under an illusion. Real estate is an asset like any other, and there is no guarantee that prices won’t fall. The biggest lesson you can learn from the real estate crisis in US is that just because something hasn’t happened earlier doesn’t mean it can’t happen in the future.

4. Resist Peer Pressure: During the peak of the crisis it was hard to avoid conversations on real estate. People in parties were talking about houses, people at your lunch break were talking about the new re-modeling they were going to do, and even distant cousins were sending you pictures of their new houses. All this made it very hard for someone to keep calm and avoid getting sucked into all the frenzy. A lot of people were handing out real estate advice, and many others were calling you stupid if you were “wasting” money on rent. There was so much excitement around house buying and selling that it became impossible to stay calm.

This is true with most bubbles, and is probably the hardest thing to control because of the psychological aspect of it.

Knowledge helps fight peer pressure, and if you’re aware that bubbles happen and have happened in the past it is that much more easier to ignore this peer pressure.

The lesson here is buying a house just because your cousin or neighbor has done so is never a good idea.

Conclusion

History is a great teacher and we should strive to learn from not only our own history, but of those around us. Public memory is usually short, and that’s why you see crash after crash and people not learning from the mistakes. Whenever you evaluate real estate investments make sure you keep these 4 factors in mind because they were pervasive just before the US housing market collapse, and you don’t want your investments to go the same way.

This is a guest post by Manshu, who blogs at www.onemint.com – the views expressed herein are Author’s Personal Views.

It will be great if you can share about your real estate investment or about property price rise in your city.

Hemant Beniwal is a CERTIFIED FINANCIAL PLANNER and his Company Ark Primary Advisors Pvt Ltd is registered as an Investment Adviser with SEBI. Hemant is also a member of the Financial Planning Association, U.S.A and registered as a life planner with Kinder Institute of Life Planning, U.S.A.
He started his Financial Planning Practice & TFL Guide Blog in 2009. "The Financial Literates" is a dream & mission to make Indians Financial Literate.

49 COMMENTS

Hi, Great Post. Thanks for sharing. I have seen people talking about buying a home rather than just paying rent.They also talk that this time it would be difficult in paying the loan amount but later when the salary will hike or the price of property will increase it would be beneficial for them.

When I started reading this article I was wondering how your views are similar to Manshu on this subject. Only when I came to the end I could know that it was actually an article by Manshu. I did not know that Manshu is based in the US.

Nice Post. Thanks to both of you for giving some info on realestate that not everything that glitters is gold. I have one query, I feel there is a lot of difference between US and India when it comes to realestate, considering the no. of people per sq/ft or any other unit of measure.

so I feel real estate prices in India have more cushion compared to US.

This is precisely the reason that proves the Real Estate in India may be in bubble zone. People come out with lot of jazzy formulas in such bubbles….”people/sqft”, “developed area/unit population”,”something/ something else” etc… to justify the price rise….

Accidentally arrived on your website while googling Sensex P/E ratio. Not only got my fundas on the topic clearer, but also got a host of other informative articles. Really, you are doing a great work. Surprising to see that no ads are there on your page. Looking forward to some idea from you as to when one regular SIP investor should sell only to invest the same later. I mean, suppose I regularly invest 10,000/- in SIP. And markets are extremely overvalued as per P/E, and I am invested for say 10 years. Won’t it make sense to sale off entire units, get the money in bank account and invest it as a whole when markets go down. I am unable to see any harm in it.

Hi Sudhanshu, You are talking about Market Timing – it’s the worst strategy to follow. As you are saying sell when market seems extreme overvalued as per P/E but what is the definition for overvaluation. Our average market P/E is close to 18 – right now it is at 19 but people feel it’s overvalued. Our markets peaked at 30 PE in 2000 & 2007 but if we talk about 1992 it was over 40. Even from 1994 to 2000 for most of the period P/E was above 25 – even in china average PE is in the same range. Japanese market peaked at P/E of 100. I just want to explain is that P/E should not be the only criteria to judge future performance of the market. My suggestion is rather than timing the market follows proper asset allocation strategy.

There are no hard rules for success. If you think you have the ability to weigh the P/E carry on. But just remember one thing, if the whole economics can be put up in a 200 page book but unfortunately the investors psychology can never be put up even in a 2000 page book. The real estate prices in the US hit their 10 year low. It is not the flow of air but the improper banking and investing strategies, improper savings that made the US to the current situation. So, there will be a reason for everything. P/E, EPS, BV, FV etc these are nothing to arrive to a value. IF you observe of the many markets, the p/E of shares in Indian market are higher. So, how to rate which is lower or higher P/E? :).

Be greedy when others are fearing and be fearful when others are greedy as said by Buffet!

Dear Manshu / Hemant, do you foresee a correction in property prices in the near future as some pundits have been forecasting? I know that it is a tricky question but wanted to know your gut feeling on this one.

Hi Vijay, Gut feelings have no place in investment world – this is just used by retail investors to speculate. Someone says “I am feeling market should go down from here” but what’s the logic – is it backed with some research. And such feeling drive people into losses. But problem is even 100 Kgs of research reports can’t predict the price direction of assets in short term. Avoid guessing – stick to asset allocation strategy.

Peer Pressure!!. It is there in other fields also. Example, if a person quits the job for his higher education, the peer fellow starts thinking about his opportunities. If one guy cracks IAS then all relatives of him put pressure on there kids by giving this fellow as an example. If some body gets good US college seat for his masters, then 100’s of kids of his age start thinking to get better college than him. Is this motivation?competition?Peer Pressure?. If a guy get good job then no body thinks of the pressure he gets while doing the job. How much time he spends with family? etc.. Therefore do not feel any peer pressure. Do whatever you feel good and interesting and worth And parallel do a some decent job. please comment your views on this.

Whenever anyone buys or sells property in my locality it provides a topic for discussion about property rates. I have not heard anybody saying that the rates of the property have fallen. People only talk about appreciation of their property. 30% is the annual return generally mentioned.

Hi Anil, There is no doubt that people have made money in Real Estate & the biggest reason is holding this asset class for long term – which is rare in case of equity. But when someone says 30% CAGR – you should use some application on your ipad to calculate it 😉

The difference between real estate market in India and the rest of the developed world.In India black money rules the real estate market and it is white money in the developed world.So a crash in Indian real estate market seems like a remote possibility or maybe less probable.At the max we could see flat growth or a a -ve growth of 10%.The real estate owners/developers have deep pockets backed by black money to sustain a downturn.

It is a myth to think that there is no corruption/black money in developed nations :). The reason why real estate is more important in any economy is not just about some real estate prices but it has to do MORE with the banking system of the economy. The minute when the ‘Property’ bubble is burst almost simultaneously the Credit bubble bursts too. Followed by banks,finance etc. Do I need to say any more? I don’t foresee any harm to the Indian economy due to this but it is the people who will lose their valuable investments.

I am from Mumbai. My dad when he bought a house in 1960… he found was extreemly expensive. My uncle when he bought in 1970.. he found expensive. When i bought house in 2000 i found it expensive. So it was always expensive and unaffordable and people still bought. The difference b/w than and now is that my father bought 120 sq ft. My uncle bought 200 sq ft and I bought 800 sq ft. Probably my son would look to buy 1500 sq ft. Is there anybody looking to buy 100-200 sq ft hse in mumbai.? It is not just per sq/ft price but our standard of living has improved a lot over the years and our expectation with disposable income has gone up many fold and banks are ready to lend if u have fat salary income. But when i look at last 10 years the property price have gone up by 7-8 times and hence price correction like 96-2002 is on the cards.

Really a nice article. once real estate regulator comes under force, situation may change somewhat. But people feel comfortable to live under their perception that property will always give positive returns. Unfortunately, majority of persons who invest in property, don’t even listen to invest in mutual funds, equity or other commodities. Aagey aagey dekhiye hota he kya. But thanks a million for such a good article. with regards

bhai sabse jyada paisa politician ka he laga hai propery mein, robert vadhera is number one real estater of india, i doubt that price will come down, even govt is not willing to regularise it as their money is also in this business

Although i don’t own anything in real estate except my house, i was also feeling that real estate price in india are extermely high n would correct soon, but i was wrong because despite my monthly income in 6 figure i am unable to buy any property in third grade city like panipat, becuase of cost in crore n i find govt clerks/class 3 employees having salary of 10-15 thousands are owning many plots n always talk in crores, reason it seems is hugh corruption in india, even i 4th class earn in lakhs , that black money is invested in property easily as on paper property cost shown in few lakhs only. That is why now i think, there will not be any significant correction in property rates at least in india where black money is in huge amount. i wasted many years thinking it will come down , but now i realise that i was wrong, plz give your expert comments

Nice Article !! Thanks for the same. I am staying in a company alotted house and for a few more years I believe we would be living in this same house. So, is it good to purchase a flat paying 60% in cash and 40% loan amount. We want to rent it out so that monthly installments will be paid out of rent. We will sell it in case its price improves in coming 4-5 years. Reason to sell bcoz location is too far from the place of our work. At present we don’t have any property, not even our own house. Please advise.

I think the first priority should be to own a house for your own living and the location is important in that context. One should think of buying a house for investment only as a second choice. If you don’t need the house for living right now then invest your savings so that you can buy it when you want to live in it.

But my plan was to create a second source of income. Although, the other investment options (MF) appear better than this investment as the second income (rent) will be used for payment of Bank installments. Still after 5-6 years I’ll end up having a property which could serve as a second source of income. Please correct me Anil ji if you have a better option. Thanks & regards, Nishi

Thanks Anil ji, In my case, property in preferred location costs atleast 10 times the price I have to pay for above said location. SO I cannot even think of buying a house/flat at the preferred location. However, I believe that in next 5-6 years the current investment (flat) will also grow to some extent + I will save/make more money so as to buy best possible flat at the best possible location. I think the property rates (although not necessary) might improve.

It is true that during the last five years investments in mutual funds have not given much to the investors whereas investments in property at good locations have given very good returns. So investing in property at correct location may be a good option for you in the long term.

Nice Article. thanks for simple and clear view of situation and your recommendation. I have a question on Investment aspect of it. Apart from the first house (which is used as residence) other properties are for investment purpose and its returns (actual profit after all deductions) should be compared with other investment of same value in the same period. Can you give some idea on how has property performed as compared to other forms of investment? And since property prices are already touching sky, does it make send to put money in Property or focus on other investments?

A very good observation on the most heated topic in India. Thanx for sharing your views. I have one query on this topic..sir,, Most of my money has got invested into mutual funds through SIPs (debt as well as in equity based) which I had kept for buying a house for the last five years. Now it seems I am stuck in it…what do you suggest at this junture to me to do whether to off load my investments as they are giving me a a very negligible return. Thanx…Satnam

Hi Manshu/Hemant, My friend has been to US for 1 year and returned back with some sulprus amt. She is still young. She wants to buy a property (flat) in Pune for investment only. She has only the 20 % downpayment amt. Rest she is planning to take a home loan . She has no other liabilities. I had an opinion , that she should invesmtent the sulprus in other investment such as MF (thru SIP) , RDs etc. Kindly give your inputs on this.

Hi Hemant Can we have more insight on real estate crashes in India. I feel that it has retained and made wealth for generations and have regulated their life styles by checking the available liquidity. It is difficult to retain liquid assets in debt and equity market as it need lot of skills and are not reliable. Pl refer me readings on reality of real estate.

i think real estate prices in india will never fall,they can be stable only,as banks are very strict about loan procedures in india compared to u.s. and so the builders are also very united in holding prices,what you think?

Hi Mr. Hemanth, I’m srinivas (age24) basically from hyderabad salaried employee but working in reputed PSU chennai with no laibilities,monthly exp is 5k . take home 55k/month.I have PPF(14k),HDFC TOP 200 (G) SIP 2k/month,LIC 12k/annum 20 years,Gold started purchasing 1gm/month since oct12, RDs, FDs, bank balance 6lacs,etc like small savings. My question is is it suggestible to purchase property (flat,/plot cum house constructon) in hyderabad at this time. is purchasing second hand flat (26lacs) to let out for rental(10k/month) suggestible in hyd? or purchase of plot? plot means currently land costs 40lacs then construction 18lacs.Will there be appreciation for flats in famous areas.But i hope plot may appreciate,how much we cant predict